Bid to boost cash flow amid crunch

Bid to boost cash flow amid crunch

Mumbai: A move by Reliance Industries Ltd (RIL) to merge its biggest subsidiary Reliance Petroleum Ltd (RPL) with itself was likely spurred by the intention to boost cash flow in the face of shrinking refining margins and an uncertain outlook for global crude prices, analysts say.

Besides proposing the merger—which the two companies’ boards will consider on Monday—Mukesh Ambani-led RIL has also cut short the timeline for reaching peak gas output from the Krishna-Godavari basin to end-2009 from around mid-2010, citing the need to improve cash flow.

Click here to watch video

191296c8-0662-11de-b39f-000b5dabf636.flvWhile analysts say boosting cash flow—a measure of the cash generated and used by a company and used as an indicator of its financial strength—was the major reason for the merger, its timing could have been dictated by US energy firm Chevron Corp.’s lack of interest in exercising an option to raise its stake in RPL from 5% to 29%.

Responding to Mint in an email, Chevron’s spokesman Lloyd Avram confirmed that the company had sold its 5% RPL stake to RIL “for an undisclosed amount". Avram cited “attractive investment alternatives, and continuing low global demand for refined products, as principal reasons for selling our interest in the Reliance refinery".

Also See Tapping Synergy (PDF)

Under an agreement between the two companies, Chevron was to have sold the 5% stake at the price at which it bought it—$300 million (Rs1,512 crore). Chevron’s disinterest in raising its stake had been suspected when its spending programme for 2009 failed to mention RPL.

Two RIL officials Mint spoke to said there was little business sense in keeping the subsidiary separate “once the Chevron thing fizzled out". RPL’s products would have to be sold in difficult times because crude prices are low, refining margins are fluctuating, the petrochemicals outlook is subdued and more refining capacities are coming up in an already oversupplied market.

“I can’t see any tax incentives or benefits from being able to charge higher depreciation on account of the merger, since these numbers would anyway have been counted in on a consolidated basis," said a Mumbai-based analyst with a foreign brokerage who did not want to be named. “Surely, RIL will be able to use RPL’s cashflows now."

RPL, in which RIL has a 70% stake, started trial production in January at its 580,000 barrels-per-day (bpd) refinery in Jamnagar, next to its parent’s 660,000 bpd refinery. With a combined capacity of 1.24 million bpd, they form the world’s largest refinery complex.

RIL informed the stock exchanges on Friday that it intends to merge the Jamnagar refinery, expected to start full-scale commercial production from April.

“The development is a near-term positive for RIL in choppy markets but clearly negative for RPL shareholders," the foreign brokerage analyst said, adding that the strategy of hiving off a new project, raising money from the market to fund it and bringing it back into the parent’s fold hedged the risk for RIL shareholders until the asset started generating revenue.

Others see more merger benefits. The merger is “likely to create operational synergies and indirect tax the form of cost optimization and better negotiating ability for buying crude. Further, there could be potential saving on dividend distribution tax...," Edelweiss Capital Ltd’s analysts Niraj Mansingka and Ruchi Vora wrote in a 27 February report.

The “amalgamation seems to be well-timed as RPL refinery project execution risks are behind and operations are due to come onstream by April 2009." They estimated an RPL to RIL share swap ratio of 18-20:1.

RIL cited both cash flow and the need to “make up for lost time" in deciding to cut short the time to reach peak gas output from the Krishna-Godavari basin.

“Earlier we had thought of commencing production somewhere in the second half of 2008 and reaching peak output 17 months later but since those timelines got pushed, we want to make up for the lost time," P.M.S. Prasad, RIL’s president and chief executive—petroleum business, told reporters on Friday at the company’s Gadimoga facility in Andhra Pradesh.

“We are accelerating that time frame, taking the output to peak levels by December this year."

Initial gas output will be 10 million standard cubic metres of gas a day (mscmd) but will reach 80mscmd by December.

The onshore infrastructure in Gadimoga, on the eastern coast in the heart of Krishna-Godavari basin, will be the key facility which will monitor the deep sea block known as KG D6, located a few kilometres away.

RIL has struck huge gas reserves and some oil here. The oil explorer and refiner will start pumping out gas in mid-March and take roughly two weeks to fill the pipeline, Prasad added, confirming that it was sealing supply deals with several fertilizer companies, but still awaiting a list of power generators recommended by the power ministry to start talks with them.

Prasad conceded that monetizing an asset quicker to boost revenues was one of the reasons for speeding up to peak production. “Firstly, the country needs this gas. Secondly, it also makes sense from the cash flow point of view and then it is better to prove our systems earlier than later," he said.

With a total development cost of $8.8 billion, RIL was expected to break even in three-four years from the date of starting production.

Simultaneously, RIL is also developing and plans to link four additional oil wells to the three existing ones in KG D6 in March and April, enhancing revenue as well as oil output, to 40,000 bpd. The oil production, started in September, had been halted due to a pipeline rupture but will be resumed in a fortnight.